Collapses Put New Pressure On Auditors

Accountants Say Role Is Misunderstood, But Lawsuits Point Fingers

Mercury Finance, Centennial Technologies, Phar-Mor and Silverado are far different businesses, ranging from lending to computers to drugstores.

Yet they all have a common denominator: Each had an outside auditor who missed massive fraud.

In just the last few weeks, three companies, including used-car lender Mercury Finance Co. of Lake Forest, acknowledged inflating their profits without their accountants catching on.

But Big Six accountant companies have been blamed before for not warning investors about financial shenanigans of the companies they were hired to audit. And it raises questions about the role and value of corporate bookkeeping and auditor watchdogs.

Stockholders injured when these wrongdoings have been exposed say it's clear the auditor's job is to warn investors when a company's books look fishy, not just to certify that the books balance and follow generally accepted accounting principles, as accountants believe.

But accountants say frauds sometimes are so well-concealed that it takes years for them to be discovered.

"We provide reasonable assurance that the financial statements are free of fraud, not absolute assurance," said David Landsittel, a partner with Chicago-based Arthur Andersen LLP and chairman of an American Institute of Certified Public Accountants committee that has recommended an addendum to the institute's accounting standards statement.

So much confusion existed that two years ago, Congress decided it had to make it clear that auditors are required to report fraud to the Securities and Exchange Commission, which could then begin to investigate a company.

Despite repeated trips to court, however, instances of company fraud and auditors who fail to detect it keep recurring. The problem stems from a basic misunderstanding about the relationship between accountants and their clients, according to accounting experts.

"Auditors don't always understand who they are working for," said Lawrence Revsine, professor of accounting at J.L. Kellogg Graduate School of Management. "In one sense, it's clear the responsibility of the auditor is to the shareholders and the board."

But to many auditors, that isn't clear.

In fact, the former chief accountant of the Securities and Exchange Commission, Walter Schuetze, has accused accountants of being "cheerleaders" for the managements of the companies that hired them.

Repeatedly, accounting firms have been embarrassed for not picking up financial irregularities and alerting the companies' owners.

The government blamed them for the collapse of the nation's savings and loan industry.

Ernst & Young, for instance, paid $40 million to settle charges that its work was faulty on the audits of Lincoln Savings & Loan Association, the nation's biggest thrift failure, which cost taxpayers about $2.6 billion.

Accountants again were sued when Phar-Mor Inc., a Youngstown, Ohio-based pharmacy chain, sought Chapter 11 bankruptcy protection after $350 million was embezzled by two of its top executives.

It is accountants who are being accused of failing to spot earlier dubious loan-loss reserves that led to the financial collapse of Mercury Finance and the bankruptcy filing of Dallas-based Jayhawk Acceptance Corp., another used-car lender.

And it is accountants who are at the center of the implosion of Centennial Technologies Inc. Stock in the Billerica, Mass.-based company--last year's best-performing issue on the New York Stock Exchange--lost nearly 80 percent of its value last week after the company defaulted on its loans and warned it may not be able to pay its bills.

The accounting industry has paid a stiff price for these failures. Through civil lawsuits, the federal Office of Thrift Supervision collected more than $900 million from the four major accounting firms involved in the savings and loan debacle.

An out-of-court settlement worth millions of dollars was paid to Sears, Roebuck and Co. and several other plaintiffs after a Pittsburgh jury found that Phar-Mor's auditor, Coopers & Lybrand, had conducted the audits in a reckless manner.

Lawsuits now pending will determine if Mercury's auditors, KPMG Peat Marwick, should have more quickly spotted the dubious loan-loss reserves at Mercury, which last week hired Arthur Andersen to replace KPMG.

And it's probably going to be lawsuits that determine if auditors didn't properly protect shareholders from the collapse of Centennial.

Although the auditors, Coopers & Lybrand, haven't been named, lawyers representing shareholders who have sued Centennial say they are prepared to cite the auditors, too.

Though KPMG Peat Marwick has been named in shareholder suits against Mercury, the accounting firm says it did the right thing.

In a statement, the accounting firm says it challenged Mercury's management a week before trading in the company's stock was halted.